Credit Easing: What it Means, How it Works, Criticisms

What Is Credit Easing?

Credit easing is a group of unconventional monetary policy tools used by central banks to make credit and liquidity more readily available in times of financial stress. Credit easing happens when central banks purchase assets such as government bonds. 

Credit easing aims to increase the resources available to financial institutions during stressful times. 

Understanding Credit Easing

The Federal Reserve is responsible for a country's monetary policy and it conducts monetary policy by three primary tools: setting the reserve requirement, the discount rate, and conducting open market operations. Depending on whether or not the monetary policy needs to be expansionary (spur growth) or contractionary (slow growth) will determine the direction each of these tools is used.

The Fed also uses a host of other tools to conduct monetary policy when traditional monetary policy tools are not enough and the economy needs to be stimulated or contracted further. One of these is credit easing. Credit easing entails an expansion of the asset side of the Federal Reserve's balance sheet. This focus on assets differentiates credit easing from other unconventional monetary policy tools, although several of these methods involve the expansion of the central bank's balance sheet.

In response to the Great Recession, the Federal Reserve engaged in credit easing by purchasing large sums of Treasuries and mortgage-backed securities (MBS). From 2007 to 2016, the Fed's balance sheet grew from $.89 trillion to $4.5 trillion. As liquidity to the banking sector increased, interest rates fell, making money cheaper for institutions. The large-scale credit easing by the Fed eventually put a halt to the banking disaster. 

The Fed began engaging in credit easing again in 2020 during the COVID-19 pandemic, which saw the balance sheet increase from $4.2 trillion in 2020 to $8.9 trillion in 2022.

Credit easing also attempts to stabilize asset prices and reduce volatility. Once the Federal Reserve began its credit easing during the financial crisis, the equity market collapse steadied and price volatility fell. 

Credit Easing vs. Quantitative Easing

Quantitative easing (QE) is a form of unconventional monetary policy in which a central bank purchases longer-term securities from the open market in order to increase the money supply and encourage lending and investment. Buying these securities adds new money to the economy, and also serves to lower interest rates by bidding up fixed-income securities. It also expands the central bank's balance sheet.

Credit easing is often used synonymously with quantitative easing; however, Ben Bernanke, the renowned monetary policy expert and former chair of the Federal Reserve, draws a sharp distinction between quantitative easing and credit easing.

"Credit easing," he remarks, "resembles quantitative easing in one respect: It involves an expansion of the central bank's balance sheet. However, in a pure QE regime, the focus of the policy is the quantity of bank reserves, which are liabilities of the central bank; the composition of loans and securities on the asset side of the central bank's balance sheet is incidental." Bernanke also points out that credit easing focuses on "the mix of loans and securities" held by a central bank.

Despite these semantics, even Bernanke admits that the difference in the two approaches "does not reflect any doctrinal disagreement." Economists and the media have largely disregarded the distinction between the two terms by dubbing any effort by a central bank to purchase assets and inflate its balance sheet as quantitative easing.

QE, traditionally speaking, however, refers to increasing bank reserves as opposed to bank assets, as was done by the Bank of Japan in 2001.

Credit Easing and the Financial Crisis

During the 2008 financial crisis, the Fed's traditional monetary policy tools were not enough to turn the economy around. The Fed had to resort to credit easing to bring further liquidity and stability to the financial markets.

The Fed enacted four rounds of credit easing between 2008 and 2014. The first round of credit easing began on Nov. 25, 2008, with the Fed purchasing $100 million in the direct obligations of housing-related government-sponsored enterprises (GSEs): Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. It also purchased $500 million of MBSs.By 2010, the Fed had purchased $1.25 trillion in MBS and over $700 billion in Treasuries.

On Nov. 3, 2010, the Fed announced its second phase of credit easing, where it would purchase $600 billion of Treasuries.After the second round of credit easing and before the third, the Fed purchased $400 billion more of Treasuries.

On Sept. 13, 2012, the Fed announced its third round of credit easing, which would allow for the purchase of $40 billion MBSs every month. This combined with the Fed's activities of extending the average maturity of its holdings and reinvesting principal payments on agency debt and agency MBS into agency MBS would increase liquidity by $85 billion per month.

On Dec. 12, 2012, the Fed announced what would be its last phase of credit easing. The Fed would buy MBSs at the rate of $40 billion per month and Treasuries at the rate of $45 billion per month. On Dec. 18, 2013, the Fed announced that its purchase program would be slowing down as its economic targets had now been met. Instead of purchasing $40 billion MBSs per month, it would be purchasing $35 billion. Instead of purchasing Treasuries at $45 billion a month, it would now be purchasing $40 billion.

At the end of the Fed's credit easing program in 2014, the Fed's balance sheet grew from $900 billion before the program to $4.5 trillion.

Credit Easing and the COVID-19 Pandemic

In 2020, when the Coronavirus hit the world and most countries went into lockdowns, the Fed once again utilized credit easing to stabilize the economy. On March 15, 2020, the Fed announced that it would purchase $500 billion in Treasuries and $200 billion in MBSs.

Criticisms of Credit Easing

As with most financial policies, credit easing comes with many critics. Those against using credit easing as a means of liquidity argue that it creates asset bubbles. When a CE policy is implemented, prices in fixed income and equity markets increase, though critics say these prices are artificial as they only increase due to the central bank's intervention.

Furthermore, critics say that the increases in prices only help those that own these assets; people that tend to be wealthier, by providing no real benefit to those less fortunate. This, therefore, leads to income inequality, widening the gap between the rich and poor.